The Optometrist's Guide to Retirement Planning
Chapter 4: How to Build Wealth and Invest Long Term
Now that you master your retirement planning, we will go over some easy-to-implement tips on ways to help you build wealth effectively over the long term. Here are 5 Key Steps to Building wealth for Retirement
(1) Pay yourself FIRST and Make it Automatic
Have you ever looked at your friends who are always complaining about money and wonder how they truly handle their finances?
They are not; they are probably living paycheck to paycheck.
It doesn’t even matter if you are making a $50,000 or $120,000 yearly income. It all comes down to how much you spend. A doctor making $120,000 salary but spending $130,000 on booze and beer, a brand new Tesla, fancy Louis Vuitton purses and “new” iPhone models has a negative net worth of $10,000 and is poorer than the homeless person down the street.
You know that one hotshot doctor who drives that fancy Mercedes Benz and wears a $30,000 Rolex watch? Yup, I can almost guarantee that he is living paycheck to paycheck and swimming in debt. He will have to work much longer in his 70s years to maintain that lavish lifestyle, and will never be financially free.
This is how poor people stay poor!
They play the victim, make excuses and constantly chase after that perfect Instagram lifestyle. I hate to break to you, you ain’t no Kim Kardashian!
Poor people get into this mindset of PAYING OTHER PEOPLE FIRST. THIS IS WRONG.
They pay the government their taxes first, they pay the credit companies first, they pay their car lease loan first, and then they might pay TicketMaster for that front-row concert tickets to see Beyoncé…. Then, the vicious cycle continues for 4 weeks until the end of the month when they are left with $20 in their checking account. Then they complain how they are unable to save! Do you know how Rich people get rich??? It is so simple.
THEY PAY THEMSELVES FIRST.
Before they even touch their paycheck, they automatically deposit a certain amount toward their 401K retirement account, toward their student debt, or toward any saving accounts for their short-term financial goals. Then, they simply spend whatever is left over. This basically forces them to really prioritize what is actually NEEDED for their monthly budget, and help to eliminate WANTS.
I know you are thinking to yourself, I barely have enough to support all my expenses within my budget!
I am going to give you a shocking statistic right now. For a single individual living in San Francisco (one of the highest cost of living in the USA), to basically survive with bare essentials such as the cheapest rent, basic groceries, medical insurance, basic necessities, etc., it is calculated that they only need $13,368 a year. This equates to $1,114 a month for basic needs. Sorry buddy, but basic needs don’t include that Netflix subscription or pricey $1000 iPhone.
So, there shouldn’t be any excuses for an optometrist making a typical minimum salary of $100,000 a year to save for retirement or aggressively paying off their student debt. Remember:
PAY YOURSELF FIRST, your 65 years old self will be forever grateful.
You should always have enough money for the basic essentials on a doctor’s salary. Anything extra above your budget, retirement, savings or student debt payments; then sure, go ahead and enjoy it.
The next step is to MAKE IT AUTOMATIC.
Being financially successful should require the most work initially but once you set up all your investments and 401K accounts, it is basically on autopilot. Most retirement accounts or short-term saving accounts will have an automatic online deposit option that can promptly withdraw from one’s checking account at the beginning of each month. The less you think about saving money, the easier that it is for you to pay yourself first.
"The Rich pay themselves FIRST. Before they even touch their paycheck, they automatically deposit a certain % amount toward their 401K retirement account, toward their student debt, or toward any saving accounts for their short-term financial goals. Then, they simply spend whatever is left over"
(2) Stick With a Passive, Low-cost Index Fund and Do Not Try to Time the market
While it is can be absolutely scary to see your retirement portfolio down 30-40% in a single year (such as the 2008-2009 Recession), it will eventually go back up as well. That is why when you are investing long term; the stock market is your friend.
If you are investing in a well-diversified portfolio of stocks and bond, we recommend a portfolio consisting primarily of the S&P 500 stock index which mirrors the top 500 companies in the USA; investors can expect an average return of around ~10% for a full stock portfolio. But obviously our return will be conservatively less, at around ~7%, as we near retirement and thus, need to allocate more bonds.
It is virtually impossible to time the market and we recommend being in the stock market at all time, despite the high and lows.
"If you are investing a well-diversified portfolio of stocks and bond, we recommend a portfolio consisting primarily of the S&P 500 stock index which mirrors the top 500 companies in the USA. Investor can expect an average return of around ~10% for a full stock portfolio"
(3) Avoid High Fees
Fees matters a lot! Even seemingly small fees can have drastic negative effects on account return over your investing lifetime!
What are some Fees to Avoid?
- (1) Asset under management (AUM) financial advisory fee: ~1-2% yearly
- (2) Loaded mutual funds: Additional fee charged (sometime up to 5%) required for you to buy the fund. Usually this fee can be charged prior to purchase (FRONT-Loaded) or after a certain time (BACK-loaded).
- (3) Actively-managed mutual funds (up to 1% fee)
Avoid actively managed mutual funds that can have a much higher expense ratio. If you have no other choices on your 401K list, the most cost we would accept is less than 1%.
Example: Let compare two typical 26-year-old newly graduated optometrist: Smart Sammy and Lazy Larry. Both have $25,000 in their IRA retirement and add $10,000 each year to his account each year. Let assume a typical 7% average annual return, both plan to retire in 40 years. Let examine the effects of DIY investing versus using a 1% Financial Advisory fee.
Scenario 1: Smart Sammy decides to do it himself and invest in a cheap, low cost index fund with Vanguard. After 40 years, his net returns for retirement is roughly $2,500,000.
Scenario 2: Lazy Larry decides, “Psh, it is just a 1% fee” and hires a financial adviser. Assuming the adviser does the ethical thing and puts him in the same cheap index fund. After 40 years, his net returns for retirement are roughly $1,910,000, resulting in a $590,000 fee in sacrificed return toward his financial advisor.
Shocking right? That is close to an average of $14,750 in advisory fees paid each year over 40 years of investing! All for some greedy "adviser" to put you in a simple index fund.
That is not the worst part of it! The financial adviser needs to somehow justify his professional fee, so he is going to over-complicate your portfolio with expensive front-loaded mutual funds (5% purchasing cost) or even worse, actively managed mutual funds (higher expense ratio cost of 1-2%, compared to a typical S&P 500 Index fund of 0.02%). This means if we include the financial advisory fee of 1-3% with the costs of their loaded or actively managed funds choice (1-5%), which can go up as high as 8%
What is Considered Low cost?
Usually a mutual fund with an expense ratio of 0.50% is a decent deal, but ideally we want less than a 0.20% fee. Great news is that over the recent years, most mainstream 401Ks nowadays, like Fidelity or Vanguard, are charging as low as 0.10%.
The take-away is that fees are important! So make you are aware and stick with a low-cost passive index fund whenever possible.
"Any index or mutual funds with an expense ratio "cost" of less than 0.20% is considered great!
If you need hire a financial advisors, consider a fee-only CFP and avoid AUM at all cost! If you want a completely hand-off with a AUM-based CFP, the most I would recommend paying is 0.50-0.75% for someone to manage my assets."
(4) Revisit your Retirement Savings Once a year
While we advocate a steady consistent investing plan, it is wise not to ignore your account entirely.
Due to the market’s gains and losses over the years, your original asset allocation (how your divide up your money among different types of stocks and bonds) will eventually shift and be out of whack.
Example: Let’s assume for today, you've chosen to invest 70% in stock index funds and 30% in bonds at the beginning of 2019. Then, as the prices of stocks and bonds changes with the market toward the end of the year, your portfolio might result in 75% in stocks and 25% in bonds.
Therefore, re-balancing is simply correcting the imbalance by returning to the original 70% to 30% allocation. A lot of investors re-balance more frequently (like every month, which is extremely excessive) or when their portfolio reaches a certain threshold (ex. 40% stocks).
We recommend keeping it simple, so Rebalancing ONCE A YEAR is good enough.
Many 401K or IRA accounts will have options to allow investors to set the % of their mutual funds to the desired stock and bond asset allocation, thus making re-balancing easy and done within 5 minutes.
(5) Increase Saving Rate Each year
While the hardest part is getting started on retirement, the next step is easy! The next step is to hike up your saving rate each year! Let say you get a raise or bonus at your job, just take 25-50% of that amount and increase your retirement saving rate by 1-2%.
Honestly, you won’t even notice the small increase 1-2% toward your retirement contribution each year, but it can have a significant effect on your future financial security. Lastly, most 401K plans have an auto-increase option, so select that switch now!
We honestly hate the term ‘retirement’. It invokes this idea of a lazy bum who is lying on a beach every single day and doesn’t contribute anything to society. We save money and invest for one single reason - to be financially free. Free to do whatever your heart desires without having to worry about paying the bill. Being financially free allows us doctors after many years of schooling and hard work to pursue our true passions and dreams.
If your dream consists of you lying on the beach drinking Mai-Tais, then GO FOR IT. If you want to continue seeing patients, just imagine how much happier your day would be, knowing that you are helping patients simply because you enjoy it and not for a paycheck.
That is what investing for the future is all about, to achieve financial freedom